More pain to come for investors?
This week, FundCalibre held its annual investment dinner for financial journalists. Speaking at the...
“Investors will have to be nimble and hold their nerve in 2017,” says David Coombs, manager of Rathbone Strategic Growth Portfolio fund, “because it’s not going to be an easy year. My motto is ‘keep calm, be smart and hold your conviction.’ We will be taking advantage of the uncertainty next year to add quality to our strategy, when others are fearful.”
“While runaway inflation is not our base case, we think that inflation will rise steadily in 2017. The pound has fallen 10% against a basket of currencies since the EU referendum and may well plumb greater depths (although we believe sterling is very undervalued on a long-term view). This short-term currency weakness feeds through as cost-push (or ‘bad’) inflation, where the prices of raw materials and labour rise. Given that we’re bumping up against full employment, and the Bank of England seems unwilling to raise rates, there’s a risk of inflation breaking higher. If growth stalls, we could also see stagflation, and prices balloon further.
“We are therefore focusing on equities with substantial operations outside the UK and non-sterling revenue streams. The UK companies we do own are those that we believe have the ability to push through price increases. We’re steering clear of cyclical businesses, especially retailers, and are avoiding lower-quality corporate credit and index-linked gilts (counter-intuitively, they would perform poorly because they are even more sensitive to changes in yields than conventional gilts).”
“We’re hedging our bets in the US. For all the furore of Donald Trump’s election to the White House, we think the new administration will be relatively restrained. We think Mr Trump will focus on deregulation while settling for moderate tax reductions and some token infrastructure projects – that should benefit US domestic companies.
“There’s a risk, however, that Mr Trump’s impetuousness gets the better of him and he follows through on threats to slap tariffs on the US’s largest trading partners and shut down free trade agreements. This protectionism could seriously damage global trade and lower growth both in the US and abroad, perhaps to the point of recession. If that were to occur, we’d cut our exposure to risk assets – equities and lower-quality bonds – the world over. Meanwhile, the US remains one of our favoured equity markets.”
“Almost 10 years after the credit crunch, the Continent continues to strain under the weight of massive public and private loans, anaemic demand and unemployment levels that threaten the social fabric of some countries. There are several national elections coming up in 2017, the most important being regional heavyweights Germany and France. While investors can take heart from the result in Austria, the resignation of the Italian Prime Minister is less helpful, and the outcome of these contests could have wide-ranging implications for the Continent, the monetary union and global trade.
“Because of this, we continue to underweight the eurozone and avoid the peripheral nations entirely. We hold strong companies whose businesses are somewhat sheltered from the single market. We also own businesses where the majority of revenues are from overseas. Added to that, we have hedged our euro exposure back to sterling, in anticipation of euro weakness.”
“For the better part of a decade following the Lehman Brothers collapse, central banks have rowed the same currents. Now, the US is likely to be the only major economy to increase its interest rate, while all others are loosening their policies or will keep them at ‘emergency’ levels. This divergence in monetary policy began in 2016 and will continue into 2017. We expect US rates to creep upwards next year, albeit in a smooth and steady fashion. Meanwhile, it’s very unlikely that we will see higher interest rates in Europe for the next three years.
“As the US raises rates, the multi-decade bull market in bonds now looks all but over. We remain underweight gilts for this reason. The few corporate issues we do own mature in roughly half the time of the benchmark 10-year gilt.”
“Despite what President-elect Trump says, US growth is unlikely to double to 4% next year, and global growth looks similarly sluggish. If growth does not jump ahead soon, the share prices of highly cyclical businesses are likely to slump as rapidly as they are now rising. We will continue to focus on companies with strong brands, high cash flow yields and low debt, particularly as those businesses have become cheaper since Mr Trump’s victory. Companies that can rely on steady streams of cash have options in difficult times, and those that can raise prices without losing market share tend to be better protected against inflation. We find most quality global companies are based in the US, which is why we continue to have a bias to North America.”
“‘Disruption’ is a tired buzzword, but it remains the dominant theme of our age – even Bank of England Governor Mark Carney has been talking about robots taking 15 million jobs. It’s easy to be blasé about the umpteenth food delivery app start-up; however, there’s no denying the rate of technological development over the past 20 years has been breath-taking. As working age populations in the Western world – and much of the developing world – begin to shrink over the coming decades, technology will have to be part of the solution if we are to retain standards of living. Broad strides are being made right now in driverless cars, artificial intelligence and the ‘internet of things’, which connects our appliances to the World Wide Web. To the more seasoned individual like me, these changes are monumental, but the younger cohort of consumers, born around the turn of the millennium – ‘Generation Z’ – has known no different. They have lived this cutting edge since birth. As this generation matures, they will drive the need for completely new products, services and means of distribution.”
“Financial assets of all stripes have been more highly correlated than usual over the past year. That is, apart from hedge funds and alternative actively managed strategies, but only because they offered dismal returns. Many investors searched for diversification in commercial property during 2016, but we think the risks continue to far outweigh the benefits at this juncture. Gold soared in the first half of 2016 before quickly giving up much of its gains in the final quarter. It remains at an elevated level and we don’t really feel comfortable owning it while rates are rising.
“Other commodities are more interesting, however. We are investigating buying a bespoke basket of materials, including iron, copper, oil and wheat, as a way of inflation-hedging portfolios and offering greater diversification into the bargain. Diversifiers should be chosen on correlation, not volatility. That can mean having to employ nerves of steel, but it usually means better portfolio performance overall. Of course, with diversifiers, it’s important to know their bones, and why and how they meet the objectives of the overall portfolio.”